In late 2020, the business bar was abuzz about the holding in In re Nine West LBO Securities Litigation, in which a federal district court, in a motion to dismiss, held that the bankruptcy trustee properly plead a breach of fiduciary duty claim by the unsecured creditors of the successor buyer against the board of directors of the selling company. This case permitted creditors of an LBO purchaser to sustain a claim against a board of a predecessor selling company – a company in which those creditors never directly had held equity.
This case has been perceived by the business bar as a groundbreaker in fiduciary duty case law, yet the holding was not surprising to the bankruptcy bar. The evaluation by the seller’s board of the sales price to the buyer was brought under state law claims in post-bankruptcy confirmation federal district court proceedings almost six years after the original date of sale and after the settlement of the usual shareholders derivative suit against the very same directors challenging the fairness of the price. While the business bar is accustomed to considering the duties to the equity holders of the seller, the case will cause heightened concern for liabilities for fiduciary duty claims by the creditors of the buyer.
Nine West was a business unit owned by a Pennsylvania corporation called the Jones Group. This corporation was publicly traded and owned four other business units besides Nine West, including Anne Klein, Gloria Vanderbilt, Stuart Weitzman and Kurt Geiger. In 2012, of the five business units, only two were profitable, Stuart Weitzman and Kurt Geiger. The Jones Group determined to sell the business in 2012 because of these difficulties. In preparation for sale, the Jones Group prepared an analysis by its investment bankers of the value of the business units and potential sales and marketing strategies. In that analysis, the investment bankers estimated that the Jones Group could sustain a debt-to-EBITDA ratio of 5.1x its forecasted 2013 EBITDA. In 2013, the Jones Group received an offer from a private equity firm that would have paid the Jones Group shareholders $15 per share by a cash infusion from the private equity group and re-levering the underlying business.
The original form of the deal was a merger, where the Jones Group would be merged into a “newco” to be called Nine West Holdings, Inc., in exchange for a $395 million cash infusion of equity and an increase the current borrowings of the Jones Group to $1.2 billion, with the Jones Group shareholders to receive $15 per share, which was approximately $1.2 billion. As part of the closing, the buyers planned simultaneously to carve out the profitable Stuart Weitzman and Kurt Geiger units to affiliates of the private equity group for a cash purchase price of $643 million, which was lower than the total $800 million price paid by the Jones Group for each unit in 2010 and 2012, respectively.
The Jones Group board approved this form of the transaction in December 2013, but only considered and approved (i.e., examined the fairness) of the part of the transaction that paid the Jones Group shareholders $15 per share and did not pass on the fairness of the additional debt or the spin out of the profitable units. While the Jones Group board approval expressly excluded a consideration of the additional debt and the carve out of the two most profitable units, the merger agreement called for all of these transactions to happen simultaneously and also required the Jones Group officers and directors to actively assist the buyers in planning the carve out transactions of the profitable units and syndicating the additional debt. The merger agreement also had a fiduciary out.
Shortly before the closing in 2014, the buyer changed the terms of the deal to reduce the cash equity infusion to $120 million and to increase the debt to a total of $1.55 billion. This new structure meant that the debt-to-EBITDA ratio was 7.8x the EBITDA calculated by the Jones Group and 6.6x the EBITDA estimated by the private equity buyer. The cash consideration to the Jones Group shareholders remained at $15 per share.
In connection with the merger, the officers and directors of the Jones Group, the Jones Group itself and the private equity buyer were contemporaneously sued in a shareholders’ derivative suit, which was ultimately settled in 2015 in New York state court. Nine West Holdings, Inc. filed for protection under the Bankruptcy Code in 2018, four years after the closing of the transaction. The directors of the private equity buyer were sued for breach of fiduciary duty as part of the bankruptcy proceedings and settled those claims for approximately $120 million. After the confirmation of the case, the bankruptcy trustee sued the directors of the Jones Group on behalf of the unsecured creditors under theories of breach of fiduciary duty.
The court analyzed the fiduciary duty principles by asking if the business judgment rule could be invoked. In that analysis, the court did not find that the Jones Group directors were protected by the business judgment rule, based on the amount and nature of the information considered by the Jones Group board.
The key part of this case is in the discussion of the reasonableness of the investigation and analysis by the Jones Group directors. The bankruptcy trustee claimed that the business judgment rule did not protect the directors because it was not reasonable to exclude considering the debt and spin offs by the buyer. The defendant directors defended by saying they had no duty or ability to consider what the buyer did with the company after the Jones Group directors sold it.
The court found that even though there was a multistep transaction, the facts that all of the steps happened simultaneously and that the Jones Group directors and officers had to facilitate the latter parts of the transaction did not permit the Jones Group directors to separate or isolate themselves from investigating and analyzing all of the transaction. The court’s finding of recklessness also enabled the plaintiffs to get past other defenses in in the corporate documents that could have limited the damages of or otherwise exculpated the Jones Group directors.
The court discussed, at some length, the importance of the several “red flags” that the Jones Group directors ignored. First, the Jones Group directors had the 2012 analysis that concluded that the total enterprise could sustain a debt to EBITDA ratio of 5.1x, and not only had the financial results of the Jones Group deteriorated since 2021, the Newco directors also were planning to spin off the two most profitable units. Second, because the deal terms changed immediately before closing, the court concluded that the board should have reconvened to reconsider the transaction under their rights to invoke the fiduciary out in the merger agreement. Recall that the price per share to Jones Group shareholders did not change, so the portion of the transaction on which the Jones Group directors had examined and gotten a fairness opinion had not changed. Finally, the total cash consideration to be paid by Newco in the spin off was lower than the sum of the original purchase prices by the Jones Group directors, when the financial results of these divisions had improved. Based on these factors, the court specifically referred to these facts as ignored “red flags” that were indicia of recklessness by the Jones Group board.
The theme from In Re Nine West is that the governing persons of a selling entity, in addition to the examination of the consideration to the current equity owners, must also analyze potential fraudulent conveyance claims by creditors. The Jones Group directors were held liable for breach of fiduciary duty for failure to investigate and consider all of the fraudulent conveyance risks of the proposed transaction. Revlon does not require a board of a selling company to actually sell the company. In Re Nine West is best read by the business bar as requiring a board to balance all potential “equity” interests at the company level and not simply the return to current shareholders.
The citation for the case is In re Nine West LBO Securities Litigation, 20 MD. 2941 (S.D.N.Y., Dec. 4, 2020) (J. Rakoff, U.S.D.J.).
Adrienne Bond is a Houston shareholder at Crain Caton & James. Bond has a specific proficiency in energy finance, securities, and LLC law, Adrienne’s client representation has included an array of corporate E&P and Oilfield Service companies as well as digital start-up organizations and entrepreneurs.
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